If you are unfamiliar with venture capital, it is money that is invested in companies that are just starting up and are in their early stages of development. Because they do not yet have a proven track record of success, they are considered high risk, but also high-potential earners.
How Does a Venture Capitalist Make Money?
The venture capital fund owns equity in the company for which it provides the investment. The interesting part about it is that the venture capital fund is usually invested only in companies that are involved in cutting edge technology like software, information technology or biotechnology.
When initial public offerings or trade sales can bring a bit of a return, venture capital becomes a part of private equity. But not all private equity is considered a venture capital.
In return for the investment venture capitalists make in a company, they get substantial control when it comes to making decisions for the company, plus they own a large portion of the company itself.
Why Do Companies Rely on Venture Capital?
When companies are just starting to get off the ground, venture capital allows them the funding they need to grow their business. At this point, bank loans or completing a debt offering are not realistic options for a company that has no history in terms of producing income.
Another reason why venture capital is popular with companies is because it creates job growth. Each year, approximately two million businesses are created just in the United States alone, but only a very small percentage (600-800 companies) receives venture capital funding. The National Venture Capital Association reports that eleven percent of jobs in the private sector come from companies who get venture capital funding.
How Do Companies Get Venture Capital?
Unlike regular lenders where a loan is made and then paid back, venture capital is made with an understanding that the venture capitalist will own stake in the company.
Of course, the venture capitalist will only make money if the company proves to be profitable. If it does succeed, venture capitalists usually end their relationship with the company when they sell their shares to another owner (usually in a three to seven-year period).
What Does a Venture Capitalist Look for in a Company?
Venture capitalists do not just invest in any start-up company. More often than not, they are looking for businesses that are unique and are offering something new, innovative and in high demand.
They also want to invest in a company that has a good business model and an effective team of managers. As long as there is the potential for high growth, the venture capitalist will make the investment.
Among the other factors that can influence a venture capitalist are:
- A real passion for the business from the company’s founders
- A real possibility to get out of the investment before the funding cycle ends
- A return of no less than forty percent a year
These all play an important part in whether or not venture capital will be provided to a company.
Keep in mind that if you are a business just starting out, you should not assume that venture capital will be coming your way. Venture capitalists are very picky about whom they choose to invest in, but if you have the qualities they are looking for including a product or service that is unlike any other and has the potential to make millions, you just might be the recipient of venture capital.